Whither Interest Rates

Will interest rates go up? The Fed will almost certainly raise short-term rates–if not in September then likely in December–if only because they’ve talked themselves into a corner. But that doesn’t necessarily mean that broader interest rates will rise.

This post by Doug Kass makes the case that they will, echoing bond guru Bill Gross. He could be right. But the counter argument is easy to see. It looks likely that inflation is significantly lower than what is reported. See, for example, this article. Instead of 1% or 2% inflation, perhaps we even have persistent deflation–let’s guess -1%. That means real interest rates are actually rather high.

If nominal mortgage rates are 4%, factoring in deflation the real rate is 5%. That’s not ZIRP! So rather than blowing bubbles, the Fed is just recognizing reality and setting short term rates at something close to the market price.

I predict that the Fed will raise rates this year. I also predict that they’ll lower them again next year. I think predictions of a big short in the bond market are not going to pay off.